Service sector tax collection: challenges

Pakistan has become overwhelmingly a services-led economy, with services contributing roughly 60 percent of GDP. Wholesale and retail trade alone accounts for nearly 20 percent of national output. Transport, warehousing, cold chains, real estate, IT, professional services, hospitality, education and healthcare make up much of the rest. Agriculture and industry account for the remaining 40 percent.

Yet Pakistan’s fiscal architecture has failed to keep pace with this transformation.

Following the 18th Constitutional Amendment, major responsibilities including agriculture, health and education were devolved to the provinces. Taxation of services also became a major provincial responsibility. Yet provincial own-source tax revenue remains below one percent of GDP, despite substantial GST-on-services collections in a few major cities.

The problem is not simply legislation. Weak incentives, limited administrative reach, poor documentation, fragmented tax systems and political resistance have prevented provinces from systematically mapping businesses, properties and service providers across divisions, districts and towns.

The missing provincial revenue

Provinces particularly underperform in services sales tax, despite record increase in FY2025-26, agricultural income tax and property tax remained meagre amount. Against an estimated agricultural tax base of Rs3.7 trillion, provincial collections were reportedly only Rs8.4 billion. Property taxation is similarly weak, with collections around 0.08 percent of GDP — far below comparable levels with regional peers. Per-capita property tax collection in Karachi has been cited at only Rs111, compared with Rs11,233 in Bengaluru.

The weakness is especially visible in sales tax on services. More than 70 percent of provincial services sales tax is reportedly collected from telecommunications, a relatively easy-to-monitor sector. This dependence demonstrates how much of the wider services economy remains lightly taxed or outside the formal net.

Wholesale and retail, professional services, hospitality, restaurants, logistics, real estate transactions and numerous other activities represent a huge potential tax base. Digital documentation, integration with federal registries and modern compliance systems could bring much of this activity into the tax net without raising tax rates.

The NFC imbalance

Article 160 of the Constitution provides for the National Finance Commission (NFC) to distribute federal tax revenues between the federation and provinces. The 7th NFC Award, implemented in 2010 alongside the 18th Amendment, increased the provincial share of the divisible pool from 47.5 percent to 56 percent in FY2010-11 and 57.5 percent thereafter.

This strengthened provincial finances. However, the federal government retained major responsibilities, including debt servicing, defence, federal administration and national infrastructure. Financing these obligations from its remaining 42.5 percent share has contributed to persistent fiscal pressure, borrowing and roll-overs.

At the same time, large unconditional federal transfers have weakened incentives for provinces to mobilize their own revenues. Why undertake the politically difficult task of broadening the tax base when substantial resources arrive automatically through the NFC mechanism?

Smaller provinces, stronger incentives, good governance &increase investment

Pakistan needs broader tax bases, better administration and stronger accountability. One way is to reconsider the four-province administrative structure and examine elevating existing administrative divisions into smaller provinces.

Pakistan’s divisions possess distinct economic, geographic and cultural strengths. Unlocking their potential requires decentralized governance, targeted investment, efficient resource management and greater administrative empowerment.

A government responsible for perhaps 6–15 million people would be closer to its economic base. Political leaders would face greater pressure to improve infrastructure and public services while encouraging investment in agriculture, industry and IT services that expand the tax base.

Competition among more economically coherent provinces could reinforce these incentives. Provinces that improve tax administration and expand the documented economy would have greater resources for development and greater political credit. Those that failed would face clearer accountability.

International experience suggests that manageable jurisdictions can improve administrative focus and accountability. China’s local governments have competed aggressively on growth and revenue generation, while India and Iran’s more provinces provide examples of stronger administrative focus.

Pakistan’s services economy is particularly suited to this approach. Governments headquartered closer to Multan, Faisalabad, Abbottabad, Sukkur, Hyderabad, Karachi or other major economic centres could potentially map and monitor local economic activity more effectively than distant provincial secretariats overseeing tens of millions of people across vast territories.

A national security imperative

Provincial tax failure is no longer merely a public-finance issue; it is a national security concern.

A state unable to mobilize adequate domestic revenue remains dependent on external borrowing, IMF programmes and repeated fiscal adjustments. Debt servicing consumes resources that could otherwise finance education, healthcare, infrastructure and development. Persistent regional disparities and inadequate public services can also deepen political and social instability.

Pakistan’s internal and external security challenges require sustainable fiscal capacity. That capacity cannot rest indefinitely on federal taxation and transfers while the country’s largest economic sector remains inadequately documented and taxed at the provincial level.

Smaller provinces will not solve the fiscal crisis overnight. But easier access to chief ministers, provincial secretariats, civil administration and policing could reduce the distance between government and citizens, strengthen trust and improve accountability.

The growing sense of deprivation in Karachi and parts of southern Punjab reflects, among other factors, inadequate infrastructure, safe drinking water, healthcare, education and timely justice. Greater administrative proximity could help address these grievances.

Tax policy, digital systems, documentation, enforcement and political will remain essential. But more accountable jurisdictions could reduce the administrative distance between governments and the economic activity they are expected to tax.

Pakistan’s economy has already shifted towards services. Its fiscal system has not. More than 15 years after the 18th Amendment, provinces have yet to mobilise adequate revenue from the dominant sector of the economy.

Broadening provincial taxation is therefore not simply about raising revenue. It is about building fiscal capacity, reinvesting in divisions and districts, improving quality of life and delivering tax justice. Ultimately, stronger provincial fiscal capacity is essential to Pakistan’s economic resilience — and its national security.

Copyright Business Recorder, 2026